Novel structures: awaiting the turn

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Novel structures such as risk retention groups and 831(b)s are fulfilling the captive needs of smaller business, but current conditions are presenting a challenge.

The ongoing soft market in the commercial re/insurance market has hardly been conducive to further captive growth and innovation, but nevertheless novel captive structures such as risk retention groups (RRGs) and group captives are becoming increasingly mainstream. As the type and size of company considering captives evolves—with increasing numbers of small and medium-sized firms (SMEs) weighing up the captive option—innovative structures will help provide a menu of options for those considering captive insurance and act as a bridge to single parent structures.

Despite the potential of novel structures, it is evident that growth has been decidedly muted in recent years. As Julie Boucher, US captive solutions practice leader and managing director of Marsh Management Services outlined, demand has been reduced by soft commercial market conditions, with pure single parent captives the overwhelming majority of new formations, although even these numbers have been down due to the cycle. Nevertheless, there has been no great exodus of captives—single parent or otherwise. Rather, more people are simply considering the commercial market due to present conditions, said Boucher. Most captive owners are however maintaining the status quo—“not a lot of increased participation [in group structures], not a lot of new participants coming in to the programmes”—but at the same time, few group captives were closing their doors in the face of the soft market. Group structures tend to be in it for the long haul.

Ian Thompson, senior vice president at Hiscox, spoke in a similar vein arguing that demand for “group captives and RRGs is driven by availability of standard market insurance ... so what we are seeing is a fairly inactive market in terms of inventive structures”. He added that there was however a feeling in the industry that the market is on the cusp of a possible turn, one that would likely see more captive formations and captive interest in response to hardening rates.Asked if take-up of captive insurance in the SME sector would help spur on growth of alternative structures, Boucher said that she sees this as a “growth opportunity for the industry”, but that current conditions are not conducive. Those industries that deploy smaller captive structures tend to be SMEs, said Boucher, with the size and form of the captive reflecting the scale of the business behind it. No particular industries stand out as employing group captives and 831(b)s, she said, rather they cover the full gamut of industries.

“If the traditional insurance options change then we will likely see companies forming more of their own structures or grouping together to form a group structure or join an existing programme. Right now, though, these types of buyers can purchase insurance, and their culture is to purchase insurance so it’s very much an education process. I think we’ll see some more activity in future, but it will be a small amount, probably not a big wave unless there’s an event in the market forcing these companies to change their risk retention,” she said.

Despite conditions being far from perfect for group structures, there are factors that may yet encourage growth. One such factor is the Patient Protection and Affordable Care Act (PPACA)—aka Obamacare—which will usher in new healthcare institutions and greater demand for medical insurance in the US. Boucher said that PPACA was “driving many discussions, but not necessarily formations”, with a lot of uncertainty surrounding how exactly Obamacare will play out. “We have seen increasing discussions around stop-loss for self-insured medical benefits programmes”, with entities grouping together to achieve economies of scale in the marketplace, she said.

Thompson, however, said that PPACA had proved to be “less important in changing the captive space than most people were anticipating. The fundamentals remain unchanged”. Physicians or hospitals still face medical malpractice events and inevitably look to insurance to mitigate such exposures, he said. The choice remains between turning to the commercial market or opting for self-insurance.

The major change, said Thompson, is in new forms of care organisation and the levels of consolidation that have resulted. The move towards accountable care organisations (ACOs), which now need to have physician groups on their books, has led to “a lot of hospitals scrambling around to buy physician groups”. The outcome of this development is that physicians are likely “to now be insured in a much larger captive”. Whether these will be single parent or group formations remains to be seen. It could mean some captive closures, but if the industry is nimble of foot, there may yet be opportunities to build new captive structures for emerging ACOs.

Addressing whether novel structures might complement the growth strategies of some of the newer US domiciles that have entered an increasingly crowded field, Boucher said that “to date, we haven't yet seen the newer domiciles say, ‘we’re going to make our mark and go for x type of captive’, instead it has been more of a case of ‘we want to know the market and we’re interested in talking to as many people as possible’”. She said that such an approach was good for the industry, with no state simply approving structures “for the sake of building their own critical mass”. However, having the option to offer structures such as 831(b) entities to potential entrants into the market can only be beneficial to any state looking to build its captive community further.

Touching upon whether smaller captives might opt for home states or those geographically near, rather than the more mature domiciles, Thompson said that “proximity is important for smaller entities. The ability to stay local in terms of geography, but also in terms of mentality and being able to go to a city like their own, will be very attractive”. And with the Nonadmitted and Reinsurance Reform Act (NRRA) portion of Dodd-Frank placing additional pressure on captives to consider the home state advantage, it could mean that smaller captive entities will most likely be located ‘at home’, with further afield or offshore jurisdictions the preserve of larger, generally single parent captives.

Finally, turning to opportunities for further innovation, Boucher said that there are still discussions to be had, “particularly with respect to segregated cell companies”. She said that many smaller companies were looking into the various forms of captives available, with discussions revolving around: “if you decide to retain this risk, this particular form provides you with these specific benefits”. Deploying capital remains an issue in the SME space, she said, and with the soft commercial market making standard insurance an attractive option few smaller firms are willing to take the captive plunge.

Nevertheless, such discussions will prove useful for when a turn in the commercial market does eventually materialise. Thompson added that he expects to see more innovative structures such as 831(b)s going forward, but added that with new regulatory challenges emerging in response to the recent financial crisis, the industry will have to come up with ways of helping captives overcome and respond to regulatory hurdles. “There will be an increasing onus pushed on captives to perform in these areas,” he concluded.

"The option to offer structures such as 831(b) entities to potential entrants into the market can only be beneficial to any state looking to build its captive community further."

Take-up of micro-captives and group structures is closely linked to the commercial cycle, with the recent soft market serving to dampen interest. Nevertheless, US innovation in the 831(b) area and the rising number of alternatives in terms of captive forms and state domiciles suggest that novel structures still have a part to play in the captive landscape. And with SMEs increasingly getting in on the captive act and a turn in the commercial market an inevitable feature of the cycle, a further uptick in alternative captive forms seems likely when conditions coalesce. Discussions now will prove an important preamble to such a turn. Open and frank dialogue with industry during this lull seems the approach the captive sector should take.